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MONTHLY INVESTMENT BRIEF

DECEMBER 2019

 

Laurent Denize

Laurent Denize,
GLOBAL CO-CIO &
GLOBAL HEAD OF FIXED INCOME


In the event of a lull in the trade war and an ongoing improvement in macroeconomic figures, it will be time to take on a tactical pro-reflation stance.

So far this year, equity market performance and flows have headed in entirely opposite directions, with 25% gains coming with heavy outflows driven by the steep and overdone drop of the fourth quarter of 2018 and the serious concerns that emerged early in the year. Investors seem to have sold into the slight upturn that began as early as January to reduce their exposure. But in an environment of zero, and even negative interest rates, those same investors forewent more than four years of estimated po-tential gains.

Indeed, based on two simple measures of estimated returns, we come, more or less, to the same outcome on expected medium-term return performances by European equities:

3% dividends + 3% EPS growth = 6%

1/PE = 1/14.7 = 6.80%

We will have further opportunities to present our 2020 scenario in further detail in our January investment strategy, but the tone is resolutely constructive for European markets, whether from an arbitrage perspective or a strong directional choice.

Indeed, the US ISM manufacturing index sent out a mixed message, slipping to 48.1 in November vs. 48.3 in October, below the 49.2 consensus forecast. Despite hopes of a Phase One agreement, the trade war continues to cloud visibility and penalise the activity of US companies. New orders slowed once again (this component fell from 49.1 to 47.2, well below the 50 threshold between expansion and contraction). Barring a breakthrough and with the risk of new customs duties loom-ing for 15 December between China and the US, patience is the watchword in the run-up to the end of the year.

Valuations are stretched in the US, and investors appear to have priced in almost all the good news. A pause for breath would be healthy and would set the markets up to take on January on a more confident footing.

To close on a positive indicator, the high-yield bond market has taken an interesting turn in the past two weeks. B-rated bonds outperformed BB bonds, which are more defensive and more closely correlated to interest rates. The slight upturn in European indicators have driven a retracing by the riskiest bonds. We expect this trend to gather strength with the new year.

All in all, in the event of a lull in the trade war and an ongoing improvement in macroeconomic figures, it will be time to take on a tactical pro-reflation stance. One way to do so would be to sell overvalued quality growth shares and to rotate into value. The same goes for bonds. Flows could move into Europe and emerging markets with the outperformance of these two regions vs. the US for one simple reason: the expected weakening of the dollar will generate substantial capital transfers. The deficit of capital inflows into Europe is estimated at USD 188 billion since the 2008 financial crisis. This is a factor in support of the market, even when taking the “Trump factor” into account.

We’ll check in again for our January investment strategy meeting. Until then, we wish you happy holidays.


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